ROBERT SIMONS ANTONIO DAVILA Compagnie du Froid, S.A. Jacques Trumen, CEO and major shareholder of Compagnie du Froid, S.A., was reviewing the performance of the three regions of the business: France, Italy, and Spain. Evaluating the performance of the regional vice-presidents was not a task that he enjoyed. Jacques had traditionally given each regional manager the same bonus: 2% of corporate profits. Jacques believed that this system avoided arbitrary evaluation criteria and encouraged open and fruitful communication among the regions about new ways of doing business The results in 2009 challenged the fairness of this evaluation system. The performance of the Spanish region had been extremely poor and had driven the company's overall profits to their lowest level in 10 years. Jacques thought that it was unfair to have the French and Italian managers pay for the problems of somebody else. But he was not sure how much Andres Molas, the manager of the Spanish division, was to blame for Spain's poor results. Compagnie du Froid, S.A. Founded in 1985 by Jacques Trumen's father, Compagnie du Froid, S.A. had grown steadily over the years to be a major competitor in the summer ice cream business. It had a dominant position in the coastal tourist areas from Perpignan to Nice and Monaco, the region where it was founded. In 2007, Jacques took over the business and re-directed the company into an aggressive growth strategy. By 2009, the company was a market leader in the eastern part of France, the northeastern coast of Spain, and northern Italy. Jacques kept a watchful eye on the efforts of the three regional managers to expand the operations to other key tourist areas in their regions, but his attention was mainly devoted to the creation of a new business: a year-round ice cream operation based in Paris. Jacques believed very much in decentralizing decision making as much as possible. Each region had its own manufacturing, marketing, distribution, and sales organization. Regional managers chose distinctive names for new products, the level and mix of advertising, and local suppliers. The central office maintained responsibility for the accounting and financial aspects of the business, development of new products in ice creams and "specialties" categories, and the sharing of experiences and learning across the regions.199-085 Cumpagnie du Frnrid, EA. Jacques exercised control of the regions through a prot planning system. The prot plan covered the upcoming scal year which began onJanuary 1. In November and December, each region prepared and submitted their initial prot plan to the central ofce. Jacques used the profit plan to discuss and supervise the expansion strategy of each region and to make sure that enough cash would be generated to support the company' s new corporate ventures. The nal phase of the profit planning process was a top management meeting which brought togetherJacques, the three regional vice-presidents, and the finance and technical ofcers to discuss new growth opportunities. A lot of time and face-to-face contact was devoted to the prot plan and, once approved, it was the guiding tool to monitor and evaluate performance. During the summer months, each region generated a profit statement every two weeks that Jacques reviewed to detect major problems. In addition, Jacques spent a week in each region to \"get a feel for the market.\" At the end of October, another top management meeting occurred to learn from the experiences over the past year and to schedule winter activities to prepare for the next season. In early December, Jacques handed bonus checks to the three regional managers. Top line revenue goals for the upcoming year were established using past growth rates and the market expectations of Jacques and the regional managers. Exchanging knowledge and experiences was a key element in shaping the growth assumptions of the prot plan. For 2009, the expected volume growth was 9% for the French region, 10% for the Spanish region, and 12% for the Italian region. Since 2005, when Compagnie du Froid introduced its rst specialty productsophisticated ice cream avors made with prime quality ingredients, the strategy had been to emphasize these specialties that enjoyed higher margins and less intense competition. This strategy became operational through the prot plan: Jacques set ambitious goals for the percentage of sales volume coming Erom specialties for each of the regions. Standard selling prices and manufacturing costs were based on last year's actuals adjusted for any expected contingencies. Efficiency standards assumed that marmfacturing would improve its year-to- year performance based on learning and better equipment. Finally, Jacques believed that the business should compensate shareholdershimself, his brothers and sisters, and top managers in the company for the risk of tying up their capital in the business. Thus, he expected a reasonable return on shareholders' investment. His reference point was 18% return-on-investment before taxes. Exhibit 1 illustrates the standards used to design the profit plan for one of the three regions. France Jean Pinoux was the manager of the French region. He was promoted to this position in 200? when Pierre Giraux, the previous manager, took over the lagging Italian operation. Jean had started as a sales representative, then advanced to be responsible for production, and nally became division manager. Jacques was pleased with Jean's performance (see Exhibit 2). His prots were above budget, and sales had increased almost 20% over the previous year. Jean had invested a lot of his time in managing the expansion into the west coast of France, negotiating with new vendors and suppliers, and arranging distribution of the product. If all this effort had paid off in 2009, the prots would have been even higher, but Jacques knew that they would have to wait several years to get the full benets from this investment. Compagnie du Fmrid, SA. 197-035 The performance in the traditional regions of the French market had been a bit disappointing. Market share had slipped from 20% in 2007 to 18% in 2009. Jean Pinoux argued that his frequent trips to the west coast had negatively affected his relationships with distributors in the east coast. The French region had bought new machines two years ago. While there had been some start-up problems, the machines ran smoothly during 2009 thanks to Jean's manufacturing expertise. The manufacturing operation was staffed with a core group of employees which supervised production and maintained the machines. Most of the workforce was people hired on an hourly basis. Jean had found a new source of revenue from a personal friend who operated a well-known restaurant in Camargue. Over the summer of 2009, Jean's friend had decided to package his meals and distribute them through supermarkets and food stores in the region. He needed refrigerated trucks to deliver his products and Jean agreed to distribute them for a fee. Most of the retail outlets were already visited by Compagnie du Froid's delivery trucks and the incremental cost to the company to provide this service was very low. Jean saw this business opportunity as a simple way to increase revenue. By the end of the summer, he had agreements with two other regional food producers to deliver their products beginning in summer 2010. He planned to work over the winter season on getting more of these deals that were easy and very profitable. Jacques was surprised by Jean's initiative, but acknowledged that there was a profit potential in the distribution business. He was concerned, however, that distribution was outside Compagnie du Froid's core business, and he felt unsure whether to follow this new opportunity (Compagnie du Froid's mission is reproduced in Exhibit 7). Italy Pierre Giraux was the manager for the Italian region. He had been in top management positions with Compagnie du Froid for the last 10 years. Previously he had run the French region, but Jacques asked him to take care of the Italian operation because it was not performing adequately. Jacques knew Pierre very well. He was an excellent manager with a very clear sense of the market Although running the smallest region in the company, Pierre had been the main force in attaining a leadership position in the French market and was a close partner in Jacques' new ventures. Pierre's performance as manager of the Italian operation had been excellent. He had attained his sales goals and expanded the distribution of the company's products into most of the western Italian coast. In the manufacturing side, he had suffered from higher wages and lower efciency than expected. The machines used in Italy had been moved from France when the new equipment was installed in France. The old machines were partly the reason for the lower efficiency, but this expectation had already been incorporated into the prot plan. Exhibit 3 shows the performance of the Italian division in 2009. Spain Andres Nlolas was the manager for the Spanish region. He had been in charge of the Spanish operation since it started in 1995. Andres was the only non-French top manager. His performance had been outstanding until 2009. He had grown the division from scratch and he was well-respected for his innovative ideas. For example, last year he had developed a vending machine to sell specialties. The idea had been so successful] that France and Italy were planning to introduce it in 2010. Andres was the most successful manager in introducing new products to the market and the other managers followed some of his marketing ideas. Unfortunately, 2009 had been problematic for several reasons. (Exhibit 4 shows the performance of the Spanish region.) New machines, similar to the ones purchased in France, were bought early in the year to increase efficiency, but they did not perform adequately until late August. Technicians from the supplier had to spend several weeks adjusting the machines. Because of these problems, Andres had run out of capacity several times during the year and he had been forced to import product from the French division. This was the rst time that Compagnie du Froid had transferred sales between regions and Jacques had decided to set the transfer price at full cost plus a 5% prot for the manufacturer (see Exhibit 5). There was some argument about the policy. Andres was not happy about it because he said that it made his division look bad, buthe accepted it as a temporary solution. In addition, the Spanish division had been forced to absorb the expenses of having people travel to France to help fit Spanish containers and packaging to the French production line. In addition, the market had been very tough that year. Unseasonably cold temperatures had driven tourism down {Exhibit 6 shows the history of sales and temperature for the various regions). Over time, Jacques had developed a rule of thumb that a 1C deviation from the mean summer temperature resulted in a 3% change in volume growth. The 2009 summer temperatures in the coastal zones of Spain had been 13C below average; thus Jacques' rule of thumb predicted volume growth to be only 4.9% rather than the planned 10%. The reaction of a large competitor to lower sales volume had been to lower prices to stimulate demand. Andres had followed with a price cut. Even with total market sales down, Andres decided to keep the level of advertising up to build market share. The Bottom Line? When Jacques nished reviewing all the information. he sat back and began to enjoy an ice cream. France and Italy had performed well, but Spain's performance had been dismal. Yet, he was unsure how each manager had performed given the circumstances. What did the differences between the profit plan and the actual performance really mean? Jacques wondered if changes in company policy might be needed. What would happen if he suddenly changed his traditional evaluation system and gave different bonuses to the regional managers? Could he come up with a compensation formula that would be fair? This would be the perfect solution: an evaluation scheme that reected each manager's performance without the discussions and tensions linked to subjective evaluation. But he was unsure if performance should be linked to {1) the profit plan, (2) strategic goals such as revenue growth, or (3) some overall measure of economic results. Perhaps he should just stay with his traditional method and give each manager a fixed percent of corporate profit. There were also issues to be resolved about transfer prices. Some of the managers Andres in particular had been unhappy with his temporary solution. And Jacques still had not decided what he should say to Jean about his new distribution arrangements. Exhibit 1 Examples of Standards for the 2009 Prot Plan (Spanish Region) Standards Spain Percentage of volume from specialties 10% Selling prices (in Euros} Ice-cream [per litre} 4.42 Specialties (per litre) 8.13 Manufacturing costs [in Euros) Dairy ice-cream (per litre} 2.61 Other ingredients ice-cream (sugar. avor. etc. per 100 grams} 1.51 Other ingredients specialties (sugar. avor. etc. per 100 grams} 2.12 Labor [wage per hour) 8.13 Labor hours ice-cream (litres per hour) 10?.20 Labor hours specialties (litres per hour) 11.04 Volume Dairy ingredientsicecream ('51; of volume) ?2% Other ingredientsice cream (grams per litre} 48 Dairy ingredientsspecialties ('16 of volume) 93% Other ingredientsspecialties [grams per litre) 1'3 Exhibit 4 Spanish Region, 2009 Results Profit Plan Actual Variance Volume Euros Volume Euros ('000) "000 ('000) ('000) Sales Data Sales ice-cream (volume in litres) 3,685 16.294 3,575 15,507 (787) Sales specialties (litres) 409 3.330 400 3.251 (79) CCC Total Sales 4,094 19,624 3,975 18,758 (866 Cost of Goods Sold Cost ice-cream Dairy ingredients (litres) 2,653 6,923 2,175 5,607 1,316 Other ingredients (100 gr.) 1,769 2,670 1,450 2,202 468 Labor (hours) 34.37 279 29.21 238 41 Cost specialties Dairy ingredients (litres) 381 994 362 933 61 Other ingredients (100 gr.) 299 633 275 571 62 Labor (hours) 37.09 301 34.73 283 18 Contribution margin 7,824 8,924 1,100 Other Costs Supervision, energy, maintenance, ... 2, 145 2,166 (21) C Depreciation 391 391 Transfer from France 2,126 (2.126) CC Operating margin 5,288 4,241 (1,047) Selling and Administrative Expenses Delivery expenses 736 758 (22) CC Depreciation of trucks 413 424 (11) Subcontracted transportation 77 (77) Selling expenses 827 786 41 1,408 ( 2 ) con Advertising 1,406 Administrative salaries and expenses 620 644 (24) Rent 100 100 Allocated central office expenses 158 193 (35) CC Profits before Interest and Taxes 1,028 (149) (1,177) Identifiable Assets Cash (average 94 98 (4) Accounts Receivable (average) 423 266 156 Plant and equipment (net of depreciation (1,669) 4,764 4,837 (73) Total identifiable assets 5,281 5,201 80 Conditions for tourism Average summer temperature 30.2* C 28.5* CExhibit 5 2009 Ice cream Transfers between France and Spain Ice-cream Cost of Total ingredients Cost per litre (in '000 Euros) Volume transferred (in '000 litres) 603 Actual Costs (in Euros) Dairy Ingredients 2.76 1.98 1,194 Other Ingredients 1.56 0.69 416 Labor 0.09 0.09 57 Allocated Fixed Costs (in Euros) Other costs 0.46 279 Depreciation 0.09 56 S&A expenses 0.04 23 5% profit margin 0.17 101 Total transfer price 3.53 2,126Exhibit 6 Historical Data-Temperature and Sales Volume France Year Temperature Sales Volume Volume Growth (degrees Celsius) ('000 litres) 1995 27.7 1,344 1996 29.2 1,435 6.7% 1997 28.4 1,484 3.4% 1998 30.9 1,714 15.5% 1999 32.9 2,031 18.5% 2000 27.3 1,984 -2.3% 2001 30.0 2,208 11.3% 2002 30.5 2,489 12.7% 2003 30.8 2,761 10.9% 2004 30.0 2,998 8.6% 2005 29.7 3,216 7.3% 2006 30.3 3,445 7.1% 2007 29.6 3,797 10.2% 2008 29.4 4,087 7.6% 2009 (budget) 4,455 9.0% Average 29.8 *C 9.1% Spain Year Temperature Sales Volume Volume Growth (degrees Celsius) 000 litres 1995 30.8 1,069 1996 31.2 1,272 18.9% 1997 29.0 1,402 10.2% 1998 31.6 1,685 20.2% 1999 29.8 1,852 9.9% 2000 28.3 2,006 8.3% 2001 28.0 1.964 -2.1% 2002 27.5 2,033 3.5% 2003 29.9 2,231 9.8% 2004 30.4 2.481 11.2% 2005 31.8 2,684 8.2% 2006 32.4 3,036 13.1% 2007 30.4 3,346 10.2% 2008 31.0 3,722 11.3% 2009 (budget) 4,094 10.0% Average 30.2 .C 10.2%Exhibit 6 Historical Data-Temperature and Sales Volume (Continued) Italy Year Temperature Sales Volume Volume Growth (degrees Celsius) (000 litres) 1999 32.2 892 2000 30.4 1,036 16.1% 2001 28.6 1,143 10.3% 2002 31.8 1,434 25.6% 2003 28.1 1,508 5.1% 2004 28.2 1,639 8.7% 2005 29.0 1,771 8.0% 2006 28.3 1,872 5.7% 2007 30.1 2,090 11.7% 2008 30.0 2.433 16.4% 2009 (budget) 2,725 12.0% Average 29.7 .C 12.0% Exhibit 7 Compagnie du Froid S.A. Mission Statement Compagnie du Froid, S.A. exists to offer customers the best in iced summer refreshments. We work as a team to produce and market only premium quality products that are known for innovation, quality, and value. In everything we do, we strive to delight our customers and offer an experience that reflects summer fun and relaxation.Exhibit 2 French Region, 2009 Results Profit Plan Actual Variance Volume Euros Volume Euros ('000 "000 ('000) "000) Sales Data Sales ice-cream (volume in litres) 4,010 17,879 4,618 20,005 2,126 Sales specialties (litres) 145 3,661 405 3,377 (284) T T C T Revenue from distribution 79 79 Total Sales 4,455 21,540 5,023 23,461 1,921 Cost of Goods Sold Cost ice-cream Dairy ingredients (litres) 2,887 7,893 3,317 9,142 (1,249) Other ingredients (100 gr.) 1,844 2.841 2.047 3.186 (345) CCC Labor (hours) 38.29 371 43.56 438 (67) Cost specialties Dairy ingredients (litres) 410 1, 121 368 1,015 106 F Other ingredients (100 gr.) 316 693 298 655 38 F Labor (hours) 40.03 388 36.02 362 26 Contribution margin 8,233 8,663 430 E Other Costs Supervision, energy, maintenance, ... 2,206 2,324 (118) U Depreciation 467 467 Operating margin 5,560 5,872 312 F Selling and Administrative Expenses Delivery expenses 861 908 (47) U Depreciation of trucks 507 510 (3) U Selling expenses 1,078 1,139 (61) U Advertising 1,141 1,070 71 F Administrative salaries and expenses 788 810 (22) C Allocated central office expenses 158 193 (35) Profits before Interest and Taxes 1,027 1,242 215 Identifiable Assets Cash (average 94 141 (47) Accounts Receivable (average) 580 634 (54) Plant and equipment (net of depreciation ( 2,322) 4,713 4.726 (13) Total identifiable assets 5,387 5,501 (114) Conditions for tourism Average summer temperature 29.8 *C 29.2* CExhibit 3 Italian Region, 2009 Results Profit Plan Actual Variance Volume Euros Volume Euros ('000) '000 ('000) '000 Sales Data Sales ice-cream (volume in litres) 2,453 10,967 2,480 11.106 139 F Sales specialties (litres) 272 2,232 276 2 253 21 F Total Sales 2,725 13,199 2,756 13,359 160 F Cost of Goods Sold Cost ice-cream Dairy ingredients (litres) 1,864 4,963 1,895 4.986 (23) U Other ingredients (100 gr.) 1,275 1,885 1,296 1.932 (47) U Labor (hours) 33.10 300 36.03 328 (28) U Cost specialties Dairy ingredients (litres) 259 689 257 676 13 F Other ingredients (100 gr.) 196 425 197 430 (5) U Labor (hours) 24.24 220 23.29 212 8 F Contribution margin 4,717 4,795 78 F Other Costs Supervision. energy, maintenance, 1,142 1.135 7 F Depreciation 109 109 - Operating margin 3,466 3,551 65 F Selling and Administrative Expenses Delivery expenses 329 315 14 F Depreciation of trucks 198 198 - U Selling expenses 314 344 (30) U Advertising 1.328 1.288 40 F Administrative salaries and expenses 558 574 (16) U Rent 122 122 - Allocated central ofce expenses 158 193 (351 U Prots before Interest and Taxes +459 _5_11 _5.6 F Identiable Assets Cash (average) 94 108 (14) Accounts Receivable (average) 377 357 20 Plant and equipment (net of depreciation 3,200) 2,763 2 764 (1) Total Identiable assets g; g; 5 Conditions for tourism Average summer temperature 29.?\" C 29.8\" C